Staff Working Paper No. 1,117
By Paul Beaudry, Paolo Cavallino and Tim Willems
Evidence suggests that monetary policy can affect long-term real interest rates, but it is not clear what drives this. We argue this occurs because very persistent policy-induced interest rate changes have only weak effects on activity. This can arise when consumption-savings decisions are not primarily driven by intertemporal substitution, but also by life-cycle forces associated with retirement. Within such an environment, we show that the impact of highly persistent monetary policy shocks is determined by two forces: an asset valuation effect, and the response of the average marginal propensity to consume out of financial wealth. Our quantitative analysis indicates that these forces roughly cancel out, allowing monetary policy to (unconsciously) drive trends in long-run real rates. Our findings also imply that very precise knowledge of r* might not be essential to the successful conduct of monetary policy.
This version was updated in July 2025.
Monetary policy along the yield curve: why can central banks affect long-term real rates?
